Hotter Commodity Transforming the Chicago Mercantile Exchange

No longer an antiquated market rooted in agricultural trade, the Chicago Merchantile Exchange has become a sleek, tech-based financial giant--thanks in no small part to a new breed of workforce strategies.

There was ample cause for celebration at the Chicago Mercantile Exchange’s second-quarter employee meeting in August. Workers were getting their first look at a new state-of-the-art office in the city’s trendy West Loop neighborhood. Record net revenue of $295 million—a 23 percent jump from the same period a year earlier—had just been posted.

Even more impressive, the 108-year-old institution that built its business by trading commodities like frozen pork bellies and cattle futures had recently become the first exchange to be listed on the Standard & Poor’s 500—a testament to the financial powerhouse into which it had evolved since going public in December 2002.

"We are particularly proud of this milestone," CEO Craig Donohue told a group of employees touring the facility.

Last month, there was another major achievement: the CME’s $8 billion acquisition of the Chicago Board of Trade, its longtime crosstown competitor. The deal, slated to close next year, could create the world’s largest financial market, with a combined value of $25 billion.

The recent string of successes is a world away from what was a bleak outlook nine years ago. At that time, the CME faced the threat of being overtaken by rivals if it did not change from being an operational organization, where traders moved commodities by bellowing at one another in a crowded pit, to being a high-tech business where millions of transactions move faster than the blink of an eye.

The CME’s survival hinged on its ability to assemble and retain an army of IT professionals who—equipped with advanced degrees in math, physics, engineering and several other sciences—would be responsible for creating cutting-edge technology to quickly deliver its products and services.

It used to be that CME employees could walk into the exchange’s frenetic trading pit with little more than a high school diploma. Much of the work was done manually and required little training.

Today, more than 550 IT specialists work for the CME, representing 40 percent of its workforce. In order to attract and retain such specialized workers, the company had to stop thinking like a traditional exchange and become a world-class technology and financial services provider, Donohue says.

The CME soon established workforce strategies in performance management, leadership development and succession planning. As a result of the workforce initiatives, CME employees can now draw annual performance bonuses. Workers also have access to sophisticated training and educational programs and are encouraged to develop technology that can be patented. This summer, the CME made it onto Computerworld magazine’s list of the 100 Best Places to Work in IT.

"IT employees tend to be on the high end of being demanding," he says. "They can afford to be selective because there is a great need for them."

Uncharted territory The CME still has its trading pit, but as a business, it has changed tremendously from its founding in 1898 as the Chicago Butter and Egg Board. The new breed of employee helped the CME pioneer electronic trading, which took off in 1997 with the introduction of "mini-size" futures contracts. Upwards of 70 percent of all trades now take place on the company’s electronic platform, CME Globex. More than 1 billion futures contracts worth $638 trillion were traded in 2005. The value of trading done at the CME in the first two weeks of the year is more than the value of trading done at NYSE all year, the CME says.

Beth Keeve, managing director of organizational development, credits employee imagination for a landmark deal with the Chicago Board of Trade in 2003 that broke down many of the barriers between the crosstown rivals and a strategic deal with the New York Mercantile Exchange, which gave the CME inroads to the lucrative energy arena.

These workforce initiatives are perceived as necessary tools to achieve profitability for the organization, says David Jones, director of professional development and organizational effectiveness at the exchange.

Employee development starts during the interview process.

"Hiring managers communicate that professional growth, through edification, will be expected," Jones says. Employees can tap professional development programs, training, rotational assignments and classes at the University of Chicago, Northwestern University and other academic institutions. The company funds six days of training annually for its IT employees, Jones says.

Learning can also stem from collaborating with vendors to create technology. CME employees often work closely with the world’s leading tech firms, including Hewlett-Packard, to develop IT solutions. The company also offers a five-day leadership summit that features management experts like Marshall Goldsmith.

Those employee development initiatives have been instrumental in bolstering the CME’s leadership by 40 percent since the company started using succession planning metrics in July 2005. The succession planning program assists the company in identifying the areas throughout the organization where there are strengths and gaps in workforce leadership. While such metrics were inconsequential in the past, they are crucial to the CME now.

"I am a recovering engineer with a love for numbers," Jones says. Workforce programs are routinely evaluated, he explains. "Nothing is ever a slam-dunk, but we keep trying."

Performance management, for example, was tweaked last year to include a teamwork component. Employee compensation across the workforce can now be affected by how well an individual works with others.

There are plenty of incentives for workers to perform well. About 99 percent of employees receive annual bonuses. The CME also offers an equity program. Some 80 percent of employees have received stock option grants, which are based on performance as well as tenure. Employees receive a one-time stock option grant after being at the company three years. Discretionary grants are also given annually, regardless of tenure, to top performers.

The CME’s stock price has shot up from $35 when the company went public to $516 in the days following the Chicago Board of Trade acquisition announcement. The compensation packages, along with the other comprehensive workforce initiatives, contribute to the company’s low turnover rate of 8 percent, Keeve says.

From traditional to cutting edge The exchange is now based on intellectual capital, says Donohue, who estimates he spends about 40 percent of his time on workforce management issues. It’s a worthwhile investment, he says, because employee-led innovations have allowed the company to carve out competitive advantages in several key areas, including diverse product lines, 24-hour trading and trading expediency.

The industry wasn’t always driven by technology, but 10 years ago a corporate battle in Europe changed the landscape. Upstart Deutsche Terminborse, now known as Eurex, created a novel electronic trading platform that brought the London International Financial Futures and Options Exchange to its knees. LIFFE, as it was known, went from being a dominant force to holding just 10 percent of the market, and was ultimately acquired by another European exchange, Euronext. This was a chilling event for the CME because its own "open outcry" platform, used in the trading pit, was similar to that used by LIFFE.

"We were shaking on this side of the Atlantic," Keeve recalls. "If it could happen to LIFFE, it could just as easily happen to us."

The tech race was on. Since then, the CME has poured more than $1 billion into its system.

Revenue is tied to speed. The faster the trade, the greater the volume and profits. Advances in technology have reduced trade execution time to about 40 milliseconds. Blinking can take longer than processing an order.

Average daily volume in the second quarter of this year was 5.7 million contracts. The rate per contract, a measure of profitability, derived from electronic trading is 60 percent higher than from the old outcry market. The drive for new technology will place an even higher premium on human capital, says Mark Lane, an analyst at Chicago-based investment bank William Blair.

Many initiatives have been developed to foster creativity. The Center for Innovation, where Nobel Prize-winning economist Myron Scholes holds a chair, was launched in 2003 to promote advancements in technology. There also is the Employee Innovation Program, which recognizes employees who file patents for their innovations. (Because they work for CME, the employees don’t own the patents; the CME does. But the inventors are named in the filings.) The exchange has honored 70 employees with monetary rewards—$140,000 paid out since 2004—an annual dinner and plaques presented by Donohue.

Mining for gems Innovation goes hand in hand with technical excellence at the CME, says recruitment manager Chris Johnson. A minor glitch in the CME’s technology could cost millions of dollars.

"It is like having a breathing machine fail while a patient is on the operating table," says one industry expert who asked not to be identified.

To help find fail-safe talent, the CME has developed a variety of strategies, including partnering with technology user groups that give recruiters access to pools of candidates with specific backgrounds, Johnson says.

Recently, the CME hosted an event for the Chicago chapter of the Java User Group. Senior-level CME programmers were on hand to tell the group about their projects.

"Working with raw technology is like being a kid in a candy shop for IT workers," Johnson says. "It helps us attract new talent."

Such recruitment tactics were pioneered by financial and health services companies, but enterprising organizations in other industries where highly skilled workers are in demand have adopted those strategies, industry expert Wheeler says.

Over time, the CME has built up an extensive database of about 90,000 candidates who have applied to the company. Recruiters can contact them if there is an opening that matches their skills.

Employees also play a crucial role in recruitment through the company’s referral program. Last year, 20 percent of new hires came through referrals, Johnson says. There is a $2,500 bonus for workers who refer a job candidate who is subsequently hired and stays with the CME more than 90 days.

Getting into the CME is tough, however. There is typically one hire for every five interviews. Candidates are tested and interviewed extensively to ensure that their skills and experience meet the CME’s standards. The interview process often involves three or four evaluators, and there have been times when teams of six to eight people have sized up a candidate. Each interview lasts about an hour, and it’s common for candidates to stand in front of a white board and solve an IT systems problem on the spot.

Such an intense screening process is rare for most companies, and is more in line with hiring practices used by tech employers like Microsoft and Google, Wheeler says.

Keeping on its toes During the second-quarter employee meeting that celebrated the CME’s successes, Donohue praised employees for their hard work. "You have allowed the company to get to this point," he said.

The employees seemed pleased with the good news, but spent little time basking in the CME’s record quarterly revenue.

Donohue describes CME employees as being highly skilled, overachieving individuals hungry for the next challenge. And the challenges are numerous. One of those will be integrating the 785 people working for the Chicago Board of Trade into CME’s staff of 1,400. There is an overlap in workforces, but industry experts say the fallout from merging the exchanges shouldn’t be severe. The CME declined to discuss the possibility of post-merger layoffs.

The merger will entail closing the CME’s historic trading pit and, by late 2008, consolidating activity in the Chicago Board of Trade’s building just a few blocks away. The board already leases the CME’s clearinghouse technology, thanks to their 2003 deal. There also are differences in their businesses. Commodities make up 2 percent of the CME’s trading activity, compared with the board’s 18 percent.

Industry experts say the CME’s acquisition of the Chicago Board of Trade was a natural response to market competition. And now, potential rivals—including the NYSE, Euronext and the Nasdaq—have made it clear that they want to emulate the CME’s success in electronic trading.

John Thain, chief executive of the NYSE, has studied the CME’s business model. Following in its footsteps, the Big Board in March simultaneously went public and acquired Chicago-based Archipelago Holdings, securing its path into electronic trading.

In July, the NYSE and Euronext proposed a merger that could create one of the world’s largest publicly traded exchanges. Similarly, the Nasdaq acquired an electronic trading platform and has amassed a 25 percent stake in the London Stock Exchange.

In the face of that kind of competition, the CME has no intention of reducing its dedication to innovation.

"We have accomplished more than we thought was possible," the CME’s Keeve says. "It has energized us and empowered us to look at everything that still needs to be done."